This article considers why a manager would choose to submit himself to the discipline of bank monitoring. This issue is analyzed within the context of a model where the manager enjoys private benefits, which can be restricted by the monitor, and is optimally compensated by shareholders. Within this setting we find that managers will submit to monitoring when they receive favorable private information. This result is consistent with event study evidence that suggests that the market has a favorable view of financing choices that increase monitoring.

[By identifying the possibility of imposing a credible threat of liquidation as the key role of informed (bank) finance in a moral hazard context, we characterize the circumstances under which a mixture of informed and uninformed (market) finance is optimal, and explain why bank debt is typically secured, senior, and tightly held. We also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders, and that in the optimal renegotiation-proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance.]

By identifying the possibility of imposing a creditable threat of liquidation as the key role of informed (bank) finance in a moral hazard context, we characterize the circumstances under which a mixture of informed and uninformed (market) finance is optimal, and explain why bank debt is typically secured, senior, and tightly held. We also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders, and that in the optimal renegotiation-proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance.

This paper explores how motivating an incumbent CEO to undertake actions that improve the effectiveness of his management interacts with the firm's policy on CEO replacement. Such policy depends on the presence and the size of severance pay in the CEO's compensation package and on the CEO's influence on the board of directors regarding his own replacement (i.e., entrenchment). We explain when and why the combination of some degree of entrenchment and a sizeable severance package is desirable. The analysis offers predictions about the correlation between entrenchment, severance pay, and incentive compensation.

We consider a directed search model in which workers differ in productivity. Productivity becomes observable to firms after assessing their workers on the job, but it is not verifiable. Firms with vacancies choose between posting a noncontingent wage and leaving wages subject to bargaining with the worker. Under wage bargaining, firms cannot optimize the trade‐off between paying higher wages and having a larger probability of filling vacancies. But wage bargaining makes wages increasing in worker productivity and so may allow firms to attract better workers into the vacancy. When workers’ heterogeneity is large and bargaining powers come close to satisfying Hosios’s rule, firms opt for bargaining. Yet, equilibria with bargaining fail to maximize aggregate net income and sometimes are not constrained Pareto optimal.

We analyze the strategic interaction between undercapitalized banks and a supervisor in a recovery and resolution framework in which early recapitalizations can prevent later disorderly failures. Capital forbearance emerges because reputational, political, economic and fiscal costs undermine supervisors’ commitment to publicly resolve the banks that miss the request to privately recover. Under a weaker resolution threat, banks’ incentives to recover are lower and supervisors may end up having to resolve more banks. When marginal resolution costs steeply increase with the scale of the intervention, private recovery actions become strategic complements, producing too-many-to-resolve equilibria with high forbearance and high systemic costs.

We consider a dynamic model in which receiving support from the lender of last resort (LLR) may help banks to weather investor runs. We show the need for regulatory liquidity standards when the underlying social trade-offs make the uninformed LLR inclined to support troubled banks during a run. Liquidity standards increase the time available before the LLR must decide on supporting the bank. This facilitates the arrival of information on the bank’s financial condition and improves the efficiency of the decision taken by the LLR, a role that can be modified but not replaced with the use of capital regulation.

We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to nondiversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside, but significant downside risk of loan portfolio returns. This helps to reproduce the frequency and severity of twin defaults : simultaneously high firm and bank defaults. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is higher than under default risk models which underestimate the impact of borrower default on bank solvency.